Saturday, October 03, 2009

A Good Book Ruined by Misunderstanding Adam Smith

“For the ‘invisible hand’ of the market is seen to lead to the most efficient satisfaction of the wants of different market participants, and in this sense to maximise the social good, merely by harnessing the selfish desires of individuals to further their own ends.” (p 7)

“The invisible hand is a metaphor for the free market’s ability to spontaneously to reconcile and balance the requirements of competing individuals pursuing their own self-interest is such a way that self-interested behaviour can unintentionally promote the interests of society as a whole.” ( p 92)

“In the years that followed publication of The Wealth Of Nations, the conditions which Smith had stipulated (in particular, the need for perfect competition) – and the implicit moral context which he, as an Enlightenment moral philosopher, which he had assumed – were not as well remembered as his central message of the power of the invisible hand. It was this image which entered Western consciousness and helped to underpin faith in human progress.” (p 95)

“In this limited-efficiency sense, modern economists have succeeded in proving Adam Smith’s first intuition with regard to the invisible hand, that a perfectly free market can ensure that the pursuit of individual self-interest or preference satisfaction, as expressed through the market-exchange mechanism, will increase the benefits of society taken as a whole.” (p 107)

CommentThe above quotations are representative of how Smith’s use of the metaphor on “an invisible hand” has elided from its original use by Smith from a summation in a “striking manner” – which is the role of metaphors – in a case where merchant traders choose between exporting their capital abroad and investing in their locality from considering the risks of each choice and their relative profitability (wholly explained in Book IV of Wealth Of Nations, chapter2, paragraphs 1-9: 456), into a general principle of how markets operate, how supply and demand sets prices, and how society benefits from competition (incidentally covered in Books I and II without any mention of "invisible hands"!)

Richard Bronk pays no attention whatsoever to the stark difference between Adam Smith’s use of the popular, 18th-century metaphor and how modern economists, roughly from the 1940s, transformed its role (from metaphor into a 'concept', a 'principle', and a 'theory') and generalised its effects into general equilibrium theory, both verbal as a 'miracle of markets' and as a mathematical "proof" of the miracle. One consequence of Bronk’s ahistorical treatment of Smith’s role in the transformation, is that he attributes to Smith modern ideas of which he was wholly innocent.

Smith favoured competitive markets over monopolies (he was not opposed to state intervention on principle, where the role was to protect the consumer, e.g., banking regulation; quality of bullion; quality of cloths, and such like). He knew nothing about "perfect competition" - an idea from the inter-war years - and regarded "harmony" as a goal, not a destimation.

Bronk writes “In the years that followed publication of The Wealth Of Nations” - first edition 1776, Smith’s last edition 1790. Even taking the last edition date, practically no interest was taken in Smith’s use of the metaphor at all. Dugald Stewart mentioned the paragraph from Book IV, in a footnote to his Lectures in Political Economy, in 1808 (later re-published in his Collected Works, 9 volumes, 1856), but hardly anybody mentioned the metaphor again until a few mentions in the late 19th century - Malthus, Ricardo, Marx for example, did not focus on it.

For Bronk to assert that Smith’s other ideas “were not as well remembered as his central message of the power of the invisible hand” is breathtaking in its “ahistorical” hyperbole. Practically nothing was said about the “invisible hand”, even in the 1880s, compared to Smith’s alleged views on laissez-faire, his “ alleged labour theory of value”, and his polemics against “tarrifs”, “mercantile political economy”, and his alleged “small government” policies.

Much of this attention dominated accounts of Smith’s economics through to the early 1930s, when the Chicago, oral tradition began to take an interest in the “invisible hand” by applying its mystical powers from risk-averse merchants to markets as a whole (remember that the challenge, such as it was, in the Great Depression began to circulate from a critique of markets compared to the “new”, albeit doomed, central planning in Communist Russia), and, from the late 1940s, the invisible hand, partly transformed into a theory, emerged in print, most famously in Paul Samuelson’s textbook, Economics, (1st edition 1948; still going strong in its 18th edition). The depression was over, but the Cold War was on.

The new, invented invisible hand, began to appear in all textbooks, and slowly at first, then in torrents in journal articles, across the media, into the rhetoric of politicians and "experts", and lastly among the general public.

Bronk wrote post the mathematical “proof” of general equilibrium (Debreu and Arrow) and, from then on, the modern invented role of “invisible hands” has never looked back. Bronk blames the modern “invisible hand”, repeatedly misattributed to Adam Smith, for its “sins, as modern economics popularises it among governments in their trenchant beliefs in unlimited progress.

His book was written as the 1999s were recovering from the 1997-98 recessions (it reads quite up-to-date in the current recession of 2007-09!). I am surprised a new, revised, edition has not been published. If it were, I bet it would not add anything about the causes of the current crisis, nor change anything about the statements attributed to Adam Smith’s culpability in failures of modern macro-management. Indeed, Bronk could quote from similar tales in support of his own that have appeared almost daily in the media, and on many Blogs, blaming the “invisible hand” for its inadequacies as a positive force.

I have no complaints about Bronk’s criticism of modern economic management (or lack of it) – in fact, I enjoyed quite a lot of his analyses (he is good, clear writer). If he disassociated Adam Smith from the modern myth of the “invisible hand”, I would have much to say in Bronk’s favour.